What is Convertible Preferred Stock?

Definition: Convertible preferred stock is a class of stock that allows the shareholder to exchange them in for a specific amount of common shares. In other words, the preferred shareholders of these shares have the option to keep the preferred shares or trade them in to the corporation for a predetermined amount of common stock.

What Does Convertible Preferred Stock Mean?

Preferred shares are typically the second class of stock issued by a corporation. These shares are quite different than common shares in a few ways. First, preferred shares typically don’t have the right to vote or exercise control over corporate decision-making or elections. These shares are often called non-voting stock because they don’t have the right to vote in shareholder meetings.

In exchange for the inability to vote, the corporation gives special preference to these shares in the way of dividends. There are many different options available for preferred shareholders, but they are typically paid dividends before any common shareholders. Many investors are attracted to this feature and tend to purchase these shares from the corporation at a higher price than common shares.

Convertible preferred stock have all the same benefits of preferred share, but they also have the added of feature of being able to convert into common shares on the shareholder’s demand.

Example

Many shareholders enjoy this option because they can speculate on the market. For example, Let’s assume a preferred share cost $100 and can be converted into 10 common shares. If the market price of the common shares were only $9, the preferred shareholder would be better off keeping his preferred shares. If the common stock increases in value to $11, the preferred shareholder could exchange his preferred shares for more valuable common shares.

Keep in mind that the conversion process is only a one-time feature. Shareholders can’t convert their preferred shares to common and back to preferred.